Profit and Loss is the income statement that investors need to know

Profit and loss statement or income statement is a document that entrepreneurs and investors must regularly monitor because it shows whether your business can generate profit or not. In this article, we will delve into what profit and loss is and why it is important for your business decisions.

What is an income statement and why is it important?

Profit and loss statement (P&L), also known as the “income statement,” is a financial report that tells the story of what happened in your business during a specific period. It includes revenue earned, expenses incurred, and whether you made a profit or a loss.

This statement is crucial for business management because it allows managers and investors to see an overall picture of the company’s profitability. It also helps in making decisions on which strategies to improve to ensure sustainable growth in the future.

Basic formula: from revenue to net profit

The core of understanding a profit and loss statement starts with a simple formula: Total Revenue minus Total Expenses equals Profit (or Loss).

When we go into detail, there are several steps in the calculation:

Sales and Service Revenue refers to cash or receivables from selling goods or services, which is the main source of income for most businesses.

Cost of Goods Sold (COGS) means the cost of raw materials, labor, and all expenses involved in manufacturing products. Subtracting this from sales revenue gives Gross Profit.

Other Income, such as bank interest, rent, or dividends, is included. Meanwhile, Selling Expenses and Administrative Expenses (salaries, office costs, marketing) are deducted. The result is EBIT (Earnings Before Interest and Taxes).

After deducting financial expenses like interest payments, you get EBT (Earnings Before Tax). Finally, subtracting income tax yields Net Income, the actual profit the company retains.

What do the different profit levels indicate?

Looking only at Net Income is not enough because each profit level tells a different story.

Gross Profit shows how much the business can price its products above the production cost. A low gross profit margin may indicate high costs or intense price competition.

Operating Profit (EBIT) reflects the efficiency of core business operations, excluding financing or investment effects. A decline in operating profit suggests issues in managing regular expenses.

Net Profit is the final result that the business owner actually receives after all expenses. It indicates whether the business can truly generate profit.

Two formats of income statements

Report Form arranges data in a top-down hierarchy, showing revenue minus expenses to arrive at net profit. It is easy to read and immediately understandable, suitable for external reporting.

Account Form divides the page into two sides: left (expenses) and right (revenue), in a T-shape, allowing parallel comparison. It is generally more reliable and accepted by regulatory agencies.

Both formats provide the same information; only the arrangement differs. The choice depends on the user’s needs and the purpose of the report.

Why analyze the Profit and Loss Statement and how?

Good P&L analysis starts with checking the period covered, which could be monthly, quarterly, or yearly. Next, compare revenue and expenses to see if the business is profitable or incurring losses.

For example, Bank of Thailand’s 2022 profit and loss statement shows a net profit of 191,077,634,015 THB, with income from interest received, gains from investment sales, fees, and others. Expenses include interest paid, employee costs, and other expenses.

Besides reviewing the profit and loss statement, investors should consider other factors such as business nature, management quality, technological capabilities, growth potential, and industry environment.

Understanding the profit and loss statement is a fundamental skill for investors and managers because it provides critical information to assess the financial health of a business and helps in strategic planning for sustainable growth.